When it comes to investment theses, my view is the simpler the better. Better because the fewer assumptions I depend on, the lesser the chance I’ve made some fundamental error in calculation or my understanding of the company and its industry. I’ve no need for spreadsheets with twenty tabs modelling gross margins for the next decade, or for novel-length PDFs with detailed biographical data of every middle manager. I look askance at projections longer than three years or so into the future, because the future so stubbornly refuses to conform to my wishes and predictions.
Visteon Corporation is an example of a simple investment thesis. Visteon is a supplier to auto manufacturers worldwide. Its biggest customers are Hyundai/Kia and Ford, and its chief products are climate control and electronics parts and systems. While Visteon has rapidly transformed its business, the market has failed to adequately recognize the progress. The case for investing in the company relies on only a few facts and assumptions.
- Visteon is overcapitalized and plans to return that capital to shareholders through a massive share repurchase. The company is authorized to repurchase $1 billion in shares by December, 2015, good for 26.2% of shares outstanding.
- Visteon has streamlined and focused its lines of business down to its highest-margin, fastest-growing operations: climate and electronics. Exiting slower-growing, lower-margin operations should merit a higher market multiple on the restructured business, yet Visteon trades at a very low multiple of projected results.
And that’s the whole of the thesis. Now allow me a little time to unpack each point.
Due to the recently announced sale of a significant division, Visteon is soon to be swimming in cash. In August, Visteon announced the sale of its portion of the Yanfeng Visteon Automotive Trim Systems joint venture to its Chinese partner. As part of the transaction, Visteon will assume majority control of the joint venture’s automotive electronics unit. The transactions will take some time to be finalized, but Visteon expects to receive $1.1 billion in cash before the end of the calendar year, then another $110 million in June 2014 and $14 million in June 2015. The transaction was born of Visteon’s desire to exit its automotive interiors businesses and focus on the more lucrative climate and electronics lines. Visteon intends to return nearly the entire proceeds of the sale to shareholders via share repurchases over the next two years.
Visteon has helpfully provided EBITDA estimates for 2014, adjusted for the sale of its joint venture stake. In 2014, Visteon expects to earn between $600 million and $640 million in EBITDA, adjusted for equity in affiliates and minority interests.
At only 4.07 to 4.34 times 2014 EBITDA, Visteon looks extremely cheap. The market is clearly not giving Visteon credit for its massive cash balance that will be returned to shareholders.
But what should Visteon be worth? Others may use different metrics, but I generally value capital intensive, cyclical industries at around 6x mid-cycle EBITDA. A 6x multiple on 2014 EBITDA would equal $96.92-$101.69 per share for Visteon.
However, there is a good case for valuing Visteon at a premium. Both of Visteon’s core divisions are projected to enjoy strong growth: 7%+ for climate and 12%+ for electronics, according to Visteon’s internal projections. And Visteon has realigned its business to emphasize attractive geographic regions. The Halla Visteon climate segment does 59% of its business in Asia Pacific markets and the electronics segment will do 37% there post the joint venture transaction, more than it does in either North America or Europe.
Asia is Visteon’s focus, so much so that the company is reportedly exploring transferring its stock listing to Hong Kong. From a bloomberg.com article:
“’In Asia, where the bulk of our business is and the bulk of the automotive industry is, this is a growth industry, but we’re not getting growth multiples,’ Chief Executive Officer Tim Leuliette said in an interview after a Bloomberg auto forum in Southfield, Michigan, yesterday. ‘We need to start being valued on where we do business, not where we’re domiciled.’”
And that’s the whole pitch. I could go on and talk about Hyundai’s increasing success or the margin expansion that Visteon projects, but none of that is necessary to see Visteon’s value. Despite good growth potential, Visteon trades at a depressed multiple. Shares should benefit as the market recognizes this growth potential, and as the company hoovers up shares by the millions. I strongly recommend checking out Visteon’s investor relations page, where it archives presentations it has made at various investment conferences.
One more wrinkle – Visteon has a series of warrants outstanding, trading under the symbol VSTOW. These warrants have a strike price of $58.80 and expire in October, 2015. These warrants could be attractive to investors looking to leverage Visteon’s stock cheaply.
Accounts that I manage hold Visteon warrants.
Can you explain more about the warrants? Are these simply call options with a strike of $58.80? What is the cost to hold these warrants? I read somewhere something like 5%.
Warrant price is currently $20.75 and VC price is currently 76.89, so the warrants are in-the-money by $18.09. If you consider the warrant premium of $2.66 ($20.75 – 18.09) as prepaid interest on a $58.80 “loan” for 2 years, the rate works out to 2.28%
So the warrants really only make you money if the stock trades above $79 in 2015. Seems like a lot more risk though as anything below that, you essentially lose your entire investment. Also, if the warrants are in the money, Visteon will be on the hook to pay out the $$? So this should also be accounted for in the common share price
i don’t say this to be a jerk…
but just to let you know
literally nothing of what you wrote (pasted below) is true/accurate/ or informed
you need to brush up on some fundamentals
“So the warrants really only make you money if the stock trades above $79 in 2015. Seems like a lot more risk though as anything below that, you essentially lose your entire investment. Also, if the warrants are in the money, Visteon will be on the hook to pay out the $$? So this should also be accounted for in the common share price”
The other commenter covered it well, but the warrants are in the money above $58.80. You will not lose your entire investment unless the stock closes below that price on the expiration date.
The warrants have no cash cost to Visteon. They are only obligated to issue you a new share of stock if you give them $58.80 and one warrant. The dilution is not a significant factor since the number of warrants outstanding is low in comparison to shares outstanding.
Thanks for the input. Couldn’t have explained it better myself. Pretty cheap leverage.
Yeah, a lot of the TARP warrants offer cheap leverage. Using the same kind of calculation (and ignoring dividends), here are the annual rates I come up with for various warrants:
GM-A – 1.52%
GM-B – 0.78%
BAC-A – 6.55%
AIG – 3.91%
HIG – 1.07%
VC – 2.35%
The share prices of BAC-A & AIG are pretty close to the strike prices, which I assume is why their rates are higher.
As far as I know, AIG is the only company that pays a dividend (which drives up the “rate”).
Do you mind explaining how you calculated that rate?
The basic formula is:
((1+int/principal)^(1/time in years))-1
For this warrant, it looks like:
((1+2.66/58.80)^(1/2))-1 = 2.23%. My original post used 2.xxx as the time, which is why the rate is slightly different.
Thanks for the response, Kevin. After mulling on your answer for longer than I care to admit, I now have two follow-up questions:
1.) Where did you derive your formula from? I must admit, I’m a bit handicapped by technology. My initial inclination was to find the implied yield on the following cash flows (which I think fairly represent a $58.80 loan with prepaid interest of $2.66):
1/1/2013: $56.14 (=$58.80 – $2.66)
These imply a rate of 2.34% (using the XIRR function in Excel). Why are we differing here?
2.) More importantly, I’m no longer sure I understand the analogy of the loan for the warrant premium. I see how the $2.66 premium is similar to an interest payment (in the sense that it is a cash outflow) and the $58.80 strike price is similar to a principal repayment (in the sense that it is a cash outflow). However, these minor similarities aside, I’m not sure I understand the analogy. What am I missing?
Sorry for the long comment, and thanks for your time.
The formula to calculate the rate is just a standard way of calculating interest rates. The idea to look at options as “loans” and “interest” came from Joel Greenblatt’s You Can Be a Stock Market Genius book (great book, btw).
Here’s the easiest way to look at it. Let’s say I want to own 1 share of VC. I could buy 1 share of VC today, and I’d pay $76.89. Alternatively, I could buy 1 VC warrant today. In that case, I’d pay $20.75 today and $58.80 in 2 years when I exercise the warrant (for a total of $79.55).
So why am I willing to pay $2.66 more (79.55 – 76.89) for my share by buying the warrant? Because with the warrant, I don’t have to pay the $58.80 exercise price until 2015. In other words, I have “borrowed” $58.80 for 2 years.
If you look at it that way, it only makes sense to consider the $2.66 as the “interest” on that loan.
Thanks so much. That explanation was crystal clear. And agree completely on that book – it’s one of my favorites, though it looks like it may be time for me to revisit it! Thanks again.
Not to belabor a likely trivial issue, but despite a bit of googling, I’m also unable to understand the origins of the formula you used. Is that specific to prepaid interest? I’m familiar with the standard compound interest formula [FV = PV(1+r/n)^nt ], which I suspect might be related to the one you used, but am not sure how.
Thanks in advance.
I calculated the interest a bit differently:
Start Value = $77.05 (latest price)
Finish Value = $80.20 ($58.8 strike price + $21.40 latest ask price)
Number of years = 1.907 years (656 days remaining till expiration divided by 365 days in a year)
And you get a implied interest rate of 2.12% annualized. Is this right?
Our formulas are the same, just worded differently. For simplicity’s sake, assume n=1 (ie an annual rate).
Your formula can be rewritten as (1+r)^t = FV/PV. Raise each side to the (1/t) power and you get 1+r = (fv/pv)^(1/t), which can be rewritten as r=(fv/pv)^(1/t) – 1.
By definition FV = PV + interest (in dollars), so the formula becomes r = (pv/pv + int/pv)^(1/t) – 1, which can be rewritten as
r = (1 + int/pv)^(1/t) – 1
Any idea what would happen to the warrants if they re-listed to Hong Kong?
One complication is that their climate segment is actually ~70% of Halla Visteon Climate 018880. Will they buy out the remainder, or sell their stake back to Halla, or continue operating as is?
I don’t believe anything would change re: the warrants. The warrants would still entitle one to buy one share for $58.80. Shares received from warrant exercise would simply be tradable on the Hong Kong exchange, but not the NYSE.
I don’t expect Visteon to make any big moves soon with Halla Visteon. They view climate as an attractive market so they are unlikely to divest, and they already control the company through their majority ownership. They are flush with capital and could afford to buy most if not all of the shares they do not own, but they have not chosen to do so.
I have disposed of my investments in automobile suppliers, because when things go south OEMs should be more stable und they are up a lot. If you back out the banking business of OEMs like BMW, especially the preferred shares are cheap, too on EV/Ebitda.
Maybe my thinking is wrong, but can’t the OEMs like Hyundai squeeze Visteon’s margins, if they feel like it? In the past e.g. VW has even renogiated existing contracts.
I agree that many of the OEMs are cheap. Suppliers like Visteon do run the risk of being squeezed on margins, but I believe this risk is lower than it has been in the past. Healthy OEMs like Hyundai/Kia that are experiencing growth are less likely to lean on suppliers when profits are already on the rise. It’s the manufacturers with stagnant or falling units sales that really may be tempted to juice productivity by pressuring suppliers.
I hate how all these companies won’t let you download their investor presentations, earnings calls, etc. I want to listen to it on my iPhone later, without streaming.
Since VC owns 70% of Halla Visteon Climate (0.7*$3.9bil=worth about $2.7-2.8 bil) on Korea exchange, does it mean that the rest of the company is selling for $1 bil-$1.1 bil? And there will be cash coming from selling JV for $1.2 bil? Am I getting it ,right?
Don’t forget to add the debt to compute the value of the rest of the company. But yes, that’s the idea.
Nice writeup. I am always cautious with companies that supply to the OEMs. The OEMs tend to be extremely price sensitive, so customer concentration is something to be particularly focused on for companies like Visteon.
That is an important consideration. I think the the overcapacity issue in the US somewhat reduced and continued demand growth in Asia, the risk of price competition is lower than is has been previously.
I looked at the presentations. It is not readily apparent to me if the 600-640mm guidance is fully-consolidated EBITDA, or if it already accounts for the 30% of HVCC that Visteon does not own. Do you know which their guidance represents?
Also, looks like your debt or EV numbers may need some adjusting to account for the 70% stake in the HVCC term loans, depending on the answer to the above question.
It’s a little hard to tell, but their EBITDA projection is discounted for minority interest. Halla Visteon has roughly equivalent cash and debt, so adjusting for the minority interest or not makes nearly no different in Visteon’s enterprise value.
Thanks. You are correct.
I also recommend you think about adjusting for the unfunded pensions.
Finally, it might also be worth your time to incorporate the current stock price of hvcc, as seen on the Korean exchange.
nice right up … these special situations are always interesting….
In addition to the complexity discount, recent bankruptcy and other cited reasons for the low stock price I think a significant additional reason, is that the actual one billion payment for the sale of their trim business to their partner in china , is heavily discounted …. As a result I am thinking the stock could pop 10% if the deal goes through (supposedly within this year) which would equate to a 50% pop of the warrents approx…
My gut instincts is only putting a 75% chance on the deal closing smoothly (a sceptic I know) as I think they will come up with an excuse that the Chinese govt did not approve the deal due to foreign exchange rules..
Thats a common excuse why chinese companies listed in NA do not pay dividends…. When you can not believe the countries own financial and GDP govt figures … you know corruption runs deep… Anyways, I think this back drop of worry has caused the discount to be too excessive…
To me it looks like there may be a 3 month to 6 month trade to be made, and also the long term aspects look compelling ….
Hi Wayne, thanks for your input. I am not inclined to doubt the transaction’s final approval. I am well aware of the issues of corruption and fraud involved with Chinese stocks and companies, but Yanfeng has been in the auto business for 30 years and has a physical footprint in multiple locations in Michigan. There’s very little doubt that Yanfeng is a legitimate operation.
You may be right though about the discount. If the market does have doubt about the transaction, the stock should pop up once the transaction is completed.
you did not incl. the 600m pension deficit bringing EV/EBITDA to 5,3x. Besides they discount the plan with 4% while assuming a hefty 7% return on assets.
And finally they apparently have a very high tax rate: This year they expect >150m on less than 300m EBT and for 2014 they guided for 125-165 on 600-660 EBITDA – corresponding to 270-330 EBT ~47-50%. If we account for this 20% markup from taxes (reducing owner earnings) we come to ca. 225-275 OE before Interest for an EV/OE multiple of 12-14x (3,2/,225-,275).
So all in all this appears to be valued roughly in line with fundamentals – what do you think?
I agree. Also, keep in mind that the non-HVCC business is pretty bad. They own a VERY slim slice of the value chain in auto manufacturing; easily replaceable; high margin pressure because OEMs look to these businesses to pinch pennies.
Pensions are strange. I can see arguments for including or excluding them in enterprise value based on the fact that they require so many assumptions. The slightest change in any one of these assumptions can have a dramatic effect. If one includes the pension, the annual pension expense should be added back to EBITDA. I don’t particularly have a big issue with using 7% as the long-term rate of return. That’s actually lower than most any other pension plan I have seen. And the 4% discount rate may be appropriate depending on where the plan is domiciled. If it’s a Korean plan that supports Halla Visteon workers, a different discount rate may be appropriate. I don’t want it to seem like I am completely dismissing the pension obligation. It’s sizable and a series of poor returns could cause the liability to grow considerably. On the other other, pension deficits can persist for years without creating a cash drag on a company and without requiring any additional contributions. In general, I choose to include pension deficits in enterprise value calculations only when the plan is clearly underfunded and will require near-term support.
The high tax rate this year is the result of the multiple asset sales. Management provided some color on that in the most recent quarterly call. I expect the tax rate to normalize going forward once the large transactions are completed.
What prices did you buy in at?
My exposure is solely through the warrants, but the common was between $70 and $75 at the time of the purchases.
HUAYU Automotive Systems Co Ltd (Visteon’s 50% partner in the Yanfeng Visteon Joint Venture) has had some very good developments lately. Please see the link below:
On 8/13, the same day the $1.2 Billion deal was announced, HUAYU also announced its intent to sell $6 Bill RMB in bonds.
On 11/5, the Chinese government approved the bond issuance.
On 11/21, HUAYU sold $6 Bill RMB in bonds. Although it was less than the initial $6 Bill RMB in bonds, I don’t think that this is an issue because $6 Bill RMB in bonds already has $14 Bill RMB in cash on its balance sheet as of 9/30/2013.
I think that this is a sign that there is a very good chance the deal will go through. Does anyone else have a differing opinion?
CORRECTION- On 11/21, HUAYU sold $4 Bill RMB in bonds. I knew this in my head as I was typing- it was just a typo
Do you have any commentary on my two above posts?
Do you mean the comments about Awilco’s drop and HUAYU selling bonds?
I think Awilco’s decline is overdone. The new taxes would reduce profitability to a small degree, but the stock is still worth something in the $30s.
I think the bond sale is evidence that Visteon’s planned divestment is on pace to be completed and Visteon will be able to proceed with its plans for a capital return.
The sale of the 50% ownership in the joint venture was completed today. Is anyone surprised that the stock price didn’t go up?
Surprised, but I honestly wouldn’t mind if the share price traded water for a few months. $840 million buys back more shares at $78.50 than it does at $85 or $95.
Have any updates on VC and the warrants? Nice move in both so far. When I read initial article, I made the warrants the largest holding in several of my accounts and have a double so far. I am looking for a target price on VC of $115 before I unload and expect to reach that by november of this year.
Wish you could cover more opportunities like this one in the USA rather than all these foreign outfits,but appreciate your work anyway.
VC is definitely a lot closer to fair value these days, but I think there’s more room to run. I would like to post more on domestic stuff, but the problem is two-fold. One, there’s not a lot of cheap stuff around and two, the stuff that does look very cheap (BFCF, MMAB and others) has already been adequately covered by other bloggers. I try to avoid duplicating efforts.
Glad you’ve made money on VC.
Thanks, I’ll check out the other 2 you mentioned. If you do see some other articles on stocks that look cheap would appreciate a head’s up. What other blogs do you look at for ideas?
Oddball stocks, Alphavulture, The Red Corner, all great stuff.
Quite the run in VC after story broke on possible breakup of company. I got some of my position sold in 49-50 area on the run(actually forgot I had a long standing limit order). Just got back the stock I sold and added some more on this recent pullback today. Thinking the selloff is a little overdone here and warrants offer another great opportunity. Many thanks for your great work, as always, appreciated. I need to treat you to dinner one of these days!
I do tend to agree that Visteon looks cheap here. I took advantage of the 105-106 prints to unload my warrants, but I’m open to getting back in at these levels. Glad you benefited from the analysis!